Insurers seek cash assets as recession looms | Alternatives

High-dividend stocks, private credit with the right underlying assets, and real assets with strong fundamentals have emerged as potential sources of revenue in a declining market for Hong Kong-based insurance companies.

That was the message of the scene as Asian investor launched its Insurance Investment Briefing in Hong Kong on September 30.

An unusual selling correlation between fixed income securities and equities as well as the regulatory changes coming into play forced insurers to reassess their allocation strategy.

Equity assets, in particular, may experience changes with the upcoming implementation of the new International Financial Reporting Standard, IFRS 17, from January 2023. Although investments in the asset class should still be factored in, growth stocks may receive less attention due to what could become a bigger regulatory headache.

Gregoire Picquot,

BNP Paribas Cardif

“For equity investments, IFRS 17 is going to be a very interesting conversation going forward. With equity volatility coming into profit and loss, all insurance companies are debating and studying the ability to classify equity as long term to avoid volatility. At the same time, you can’t remove equities entirely, so high-dividend-paying stocks start to make more sense,” Grégoire Picquot, BNP Paribas Cardif’s chief financial officer, said on stage.

He said that, overall, equities are facing current market uncertainties and growing expectations that a recession will be here to stay.

“Equity is always attractive. It is part of the investment universe of long-term investors and it will be our long-term friend, but perhaps not our best friend right now. I don’t think it’s the right time to intervene, from a tactical point of view. We have to be a little patient,” Picquot said.

ALTERNATIVES TO TRACING

Courtney Wei, deputy general manager of the investment management department of China Life Insurance (Overseas), agreed that it makes more sense to look at equity with a cash flow-generating approach than growth equity.

Courtney Wei,

Life in China

This is particularly driven by regulatory changes and risk-based capital requirements where equities will face capital charges similar to private equity, while facing greater volatility. They also won’t enjoy the same liquidity premiums that are achievable with private equity, she said.

“But another key driving force is the market, and given what we’re going through in the market, hopefully we’ll reach a point soon where it’s a good time to enter the equities space, and then equities will continue to be our long-term friend,” Wei said.

Instead, she sees real assets among alternative investments as a place of potential in a market where high inflation is eating away at investment performance. Additionally, it focuses on assets that are somewhat uncorrelated to financial markets.

“We are looking at strategies within, for example, real estate that are not so much dependent on the valuation of properties, but rather the cash flow of those properties. So by researching or investing in this area, we may have certain parts of our portfolio that perform differently from the macro environment,” Wei said.

Caution on loans

For Picquot, private credit in the form of direct lending offers potential in today’s market. High interest rates mean direct lending is a relatively attractive asset class, although it does offer some caveats.

“Direct loans are an option, but I would be very cautious about the nature or quality of direct loans you currently place in your portfolio. If we think the recession is going to be a long or medium-term game, you have to be a little careful about the underlying assets you’re going to pick for it,” Picquot said.

He explained that investors need to view the target sector from a purely macro perspective and look at the underlying fundamentals, rather than just evaluating the asset class itself.

Max Davis,

Wellington Management

Max Davies, insurance strategist at Wellington Management, said the alternatives are seen as offering a very well-established playbook for investment allocation, potentially providing additional return for a liquidity premium and incurring no additional capital for illiquidity in most cases.

“Alternatives have for some time been one of the antidotes insurers have been using against the low yield environment. However, now the narrative is moving further away from attractive alternatives from a yield perspective and more from a diversification perspective,” Davies said.

“For example, in private credit. Much has been said now about the diversification properties of private credit. Right now I would be suspicious because there is huge manager selection risk, and you need a manager with strong sourcing capabilities and industry experience. But it is possible to adjust the covenants to give you protection against declines in private credit,” he explained.

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